Introduction

Our first article on Charlotte’s Web [TSX: CWEB] (OTCQX:CWBHF) provides an outline of the company’s business and the CBD industry as a whole, which has seen rapid growth over the past couple of years. This has been driven by rising public interest in the compound, which is a non-intoxicating cannabinoid with purported benefits for anxiety, sleep problems, pain, and other ailments.

In this article, we will provide updates and commentary on recent company and industry-specific developments. We believe the company’s continued growth and leading position in the space provide an attractive risk-reward profile to investors, but there are regulatory risks that merit consideration.

Financial Snapshot as of September 7, 2019 (in millions USD)

Share Price (OTCQX:CWBHF)

17.24

Shares Outstanding

106.3

Market cap

1,832.6

Debt

4.2

Cash

69.1

Enterprise Value

1,767.7

(Source: Yahoo Finance)

Q2 Results Summary

The following are highlights and important updates from CWBHF’s Q2 2019 earnings release:

Q2 revenues clocked in at $25.02 million, which represents a 15% sequential increase from Q1 2019 and a 45% YoY increase from Q2 2018.

Guidance for FY 2019 revenue remains at $120-170 million, and management mentioned on the call that whether the company hits on the low or high end of this guidance depends on how the FDA decides to regulate the industry (more on this later).

The total number of retail locations selling CWBHF products is now 7,871. However, major FDM (food, drug, and mass) retailers that the company is partnered with (CVS (NYSE:CVS), Kroger (NYSE:KR)) only carry the company’s topical products.

Overview of Regulatory Framework

One of the key points in the Brightfield Group’s latest report and CWBHF’s latest earnings call was the type of regulatory approach the FDA will take on CBD. There are several ways that the FDA could move to regulate CBD:

Option 1: The FDA could impose a strict, hardline approach and prohibit the sale of all CBD products except for FDA-approved drugs such as Epidiolex that are used to treat rare forms of epilepsy. This would occur if the FDA came to regard CBD as a prescription drug that shouldn’t be legal for consumption as a wellness or dietary supplement.

Option 2: The FDA could permit the sale of certain CBD products such as tinctures, capsules, and pet products while prohibiting the sale of CBD-infused foods and beverages.

Option 3: The agency could permit the sale of all CBD products, given that it is generally recognized as safe for human consumption and there is little to no evidence of adverse side effects.

We believe Option 2 is the most likely outcome since the FDA risks public embarrassment and scrutiny if it chooses Option 3, and it is discovered in the future that CBD has certain negative side effects. We would imagine that the FDA will take a relatively cautious approach to CBD, given its close biological relationship to THC-based marijuana, which is still a federally illegal Schedule I substance.

We also don’t believe Option 1 is likely since there is an abundance of public enthusiasm and interest in CBD, and (as mentioned earlier) CBD is recognized by most as non-toxic and safe to consume. According to a pharmacology researcher quoted by Newsweek, “There are no credible issues with toxicity, and most people tolerate it quite well.”

However, it would be premature and naïve to rule out Options 1 or 3 completely, which is why there is both considerable risk and considerable upside to investing in the CBD industry now. Option 1 would severely dampen the future prospects of companies like Charlotte’s Web, whereas Option 3 would allow these companies to achieve greater top-line growth and scale quickly.

Interest in CBD Remains Strong

Charlotte’s Web future growth depends critically on whether public interest in and consumption of CBD products continues to grow. Interest in CBD started to increase rapidly beginning at the start of 2018 and has continued since. Search interest for CBD is now higher than that of marijuana and cannabis combined:

(Source: Google Trends)

This rise in public interest is translating into a booming industry. Investment bank and financial services firm Cowen & Co. estimates that 2018 sales of CBD ranged between $600 million and $2 billion and forecasts this number to rise to $16 billion by 2025. The firm’s research also suggests that 7% of Americans are currently using CBD.

The Brightfield Group’s latest report forecasts $5 billion in CBD sales in 2019 and $23.7 billion by 2023. This report argues that CBD has transformed from “a niche product to a full-blown, more normalized (and less stigmatized) mainstream wellness product available in various known retail channels”, which has contributed to the industry’s rapid growth.

Fundamental Valuation

At first glance, shares of the company appear expensive. CWEB’s current enterprise value of $1.8 billion, and LTM sales of $85 million imply an EV/sales multiple of 21x. However, looking at the company in this way provides an inaccurate picture, given how quickly the company is growing its top-line.

Assuming that management can hit ~$145 million in sales in 2019 (the midpoint of its full-year guidance of $120 to $170 million), we see a clear path to ~$450 million in sales by 2022 if the company can execute and the industry continues to grow quickly. Of course, these numbers will certainly fluctuate, given that future sales and profitability are dependent on a number of variables that are impossible to forecast perfectly.

(Source: Company filings)

Sales and marketing and G&A expenses have increased in 2019 as a % of net revenues, but we are not particularly concerned about this development as of now because we expect that the company will need to spend right now in order to maintain and extend its lead in the CBD space. This is an industry that is poised for massive growth within the next few years, and investments now should pay dividends down the line.

Final Thoughts

An investment in Charlotte’s Web remains a speculative bet for a number of reasons – uncertainty with regards to the regulatory framework that the FDA will use; unknown future growth rates of the CBD industry; and the proliferation of public and privately-traded competitors.

However, management has done an excellent job thus far of executing and maintaining its lead as the top CBD company in what is developing into a major industry. Given this, we are cautiously optimistic on both the future of Charlotte’s Web and the CBD industry as a whole and will keep readers updated via articles on this site. Thank you for reading, and we welcome all comments and feedback!

Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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